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May 17, 2012

Buyout Options Gaining a Foothold in Deals Means that More than the Price Is Right

Buyout rights are attractive to smaller firms as they offer up-front payments and a longer-term path to liquidity.

Buyout Options Gaining a Foothold in Deals Means that More than the Price Is Right

Big biopharmas scrambling to cut R&D costs as the patent cliff looms are adding collaborations with future buyout provisions to their arsenal of tactics to keep growing. [© Vladimir Volkov - Fotolia.com]

  • In January when Genentech signed a three-year deal to collaborate with Constellation Pharmaceuticals on epigenetics and chromatin biology drug programs, Constellation got $95 million to cover up-front fees and research funding plus the possibility of undisclosed “substantial” development and commercialization milestone payments as well as up to double-digit royalties.

    In return, Genentech won future rights to acquire the rest of the company. Any acquisition by Genentech would be based on prenegotiated terms, namely a “significant” initial payment plus contingent value rights payments based on the success of multiple products.

    Buyout option deals like these are not as common as milestone-driven agreements, but they have been happening more often in recent years. Deals involving buyout rights have two features that make them attractive to smaller partners: up-front payments and a longer-term path to liquidity for their investors.

    Pharma continues to hedge its bets on smaller biotechs, even absent proof that their new drugs will succeed, but traditionally, that hedged bet is reflected in success-based payments tied to development, regulatory, and sales achievements. “At some point, those economics become less attractive to the large companies,” Sushant Kumar, Ph.D, partner at Mehta Partners, pointed out to GEN. “They say, ‘It’s better for me to acquire the smaller company and get all the cash flow coming into my books.’”

    And with big biopharma still scrambling to cut R&D costs as the patent cliff looms, it’s fair to say the number of collaborations with future buyout provisions will increase, at least short-term.

    “It makes a lot of sense, especially in pharma and biotech, because to the large companies, a lot of value of the smaller companies lies in the programs they have that may still be under development. So a lot of that value lies upon future success,” Dr. Kumar said.

  • Collaborations with Buyout Potential

    Another example of an acquisition option deal is ViroPharma’s agreement with Meritage Pharma, signed in December 2011. Meritage is developing a treatment for oral budesonide suspension (OBS). ViroPharma paid an initial $7.5 million plus another $12.5 million toward OBS development up to the Phase II stage and for the right to buy Meritage.

    After ViroPharma receives final Phase II data and comes to terms with FDA on an acceptable clinical endpoint for the Phase III trial, ViroPharma will have an option to acquire Meritage for $69.9 million plus undisclosed additional payments upon the achievement of certain clinical and regulatory milestones.

    In September 2011, Crescendo Bioscience, a developer of diagnostics for patients with autoimmune disorders, won a $25 million strategic debt investment from Myriad Genetics. It came in the form of a six-year loan at 6% interest, with interest payable annually and principal payable upon maturity. In return, Myriad won an exclusive three-year option to acquire the company.

    Myriad, a $402 million-a-year company with nine molecular tests, can exercise that option if Crescendo achieves a certain revenue milestone during the three-year option period. Should that happen, Myriad will pay a price equal to a predetermined multiple of revenue based on Crescendo’s growth rate when the option gets exercised. Even if Crescendo does not reach that minimum revenue milestone during the option term, Myriad can still exercise the option and acquire Crescendo, albeit for a fixed purchase price. In any case, that purchase price will be all cash.

    Myriad was attracted to Crescendo because the deal would add rheumatology to Myriad’s portfolio of tests for oncology, urology, dermatology, and neuroscience. For Crescendo the deal accounts for almost half the $56 million it raised last year. The rest came from a $31 million series C equity financing round the same day it inked the Myriad deal.

    Crescendo will use the money to bolster commercialization of its initial product, Vectra™ DA for RA, and to expand its pipeline of molecular diagnostics for other inflammatory diseases. Crescendo says Vectra DA is the first blood test that can determine the level of disease activity in RA patients.

  • Dealing with the Downturn

    Crescendo was among a relatively small number of companies to land traditional equity funding last year—446 versus 488 in 2010, a nearly 9% decline. The dearth of equity financing for earlier-phase startups will likely prompt many more to seek deals with larger partners, rather than stick it out and wait for the equity market to return to activity levels unseen since before the Great Recession.

    Terms that include an eventual buyout could sweeten the deal for some, as the public market hasn’t been very receptive to biotechs in the recent past. Even if the budding recovery of the IPO market over this past year sticks, it likely will not dampen the interest from early-stage companies for collaborations and deals that include buy-out options. While five companies so far this year have gone public, they are more later-stage companies.

    And the IPO market is far from healthy; the latest IPO, Rib-X Pharmaceuticals postponed a planned IPO last Wednesday, a day after cutting its amount raised (from $75 million to $65 million) and share price range (from $12–$14 to $6–$7). Then again, Rib-X is focused on antibiotics, which has faced investor resistance because of lower returns on investment and more red tape than chronic disease drugs.

    What could deter startups from doing deals involving being bought out eventually is a major improvement in the IPO market. In terms of M&A activity, most do not expect a slowdown this year, given recent blockbuster purchase attempts from, for example, GlaxoSmithKline (for Human Genome Science) and Roche (for Illumina). Burrill & Co., however, recorded $45.6 billion in global M&A activity between January and April, down 43% from the amount for January–April 2011. Last year’s number included two colossal deals: Sanofi’s $20.1 billion Genzyme acquisition and Johnson & Johnson’s $21.3 billion buy of Synthes. Subtract both and year-ago M&A deal volume was $39.2 billion, a 16% increase this year. Even if the amount of 11-digit acquisition prices decreases, companies are expected to continue their buying spree, making buyout options in collaboration deals an attractive avenue.


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